Analyzing International Relations and American Politics

Does China’s Holding of U.S. Debt Matter?

No. Not in the slightest. And the reason is simple. China would have nothing to gain. Indeed, the entire bout of fear-mongering is doubly ironic when one realizes that it is often posited by Republicans who simultaneously want China to raise the value of their currency, the renminbi, to allow American manufacturers to better compete with their Chinese competition who thrive off of low wages and low currency values. But it is the very holding of U.S. debt that allows China to maintain such low exchange rates and compete with qualitatively better U.S. heavy industry. If China were to sell off its holdings of American debt, the renminbi would soar in value and thus undercut the primary driver of Chinese growth – heavy industry and exports – at a time when China’s economy is facing major instability both in its stock market and overall GDP growth rate (see here, here, and here). It would also undermine Chinese holdings in the short term because any dollar depreciation triggers capital losses in China’s external investment portfolio.

Another reason why the threat of a Chinese debt sell-off is minute is that the U.S. is extremely reliable. Countries can count on the United States to pay the yield on its debt when it’s supposed to, meaning that U.S. debt is viewed as very safe. The very fact that interest rates remained vanishingly low throughout Obama’s stimulus and Janet Yellen’s QE policy demonstrates this simple truth. While a Chinese sell-off would undoubtedly send the currency exchanges into a panic, it wouldn’t undermine the overall strength of the U.S. economy and the reliability of the U.S. government. Sure it would not be pretty to watch, but before too long other countries would snap up cheap, reliable American debt and China would have lost any leverage it had through its debt holdings. In other words, in order for financial sanctions to be effective, the target country must lack other lines of credit, and that condition simply isn’t true for the United States.

Finally, it’s unclear why China would initiate a policy that would surely invite massive and immediate retaliation. Great powers like the U.S. and China are, by definition, able to respond to provocations and attacks. Thus, unless a conflict seemed imminent, it’s unclear why China would ever risk seriously provoking the only country on the planet capable of dealing it serious damage. And, even if China and the U.S. were to find themselves on the brink of war, the empirical record is highly mixed regarding economic interdependence and conflict initiation. For example, WWI still occurred despite the tight financial interdependence of Britain and Germany, and Japan was undeterred by the seizure of its assets by the United States in the late 30s.

So, the next time you hear some pundit bemoaning the immense strategic advantage China possess through its holding of U.S. debt, know that they have no idea what they are talking about!